Current Market Analysis

More than six weeks into the new year, the market continues to climb steadily higher. Amazingly, the market is ignoring the troubles in the Middle East, dismissing the severe lack of job growth in our economy and the desperate debts weighing down our federal, state and local governments in this country. So what is propelling the markets higher? Cash, low interest rates and corporate profitability. The government has created a party and we're all invited, that is until the bills have to be paid. But for now, the bubbly is flowing so we can enjoy the buzz.

As I write this on an unseasonably warm Thursday afternoon, the Dow Jones Industrial Average is trading at a new two-year high of 12,315, 3.9% higher than it was five weeks ago. In December I wrote about excessive optimism in the market, which suggested that a correction might be forthcoming, Two months later the Dow is still rising unabated, so watch out; the correction will come, sooner or later. But when it comes, I believe it will just be a pause that refreshes, setting the stage for a continued bull market.

So let's look at some charts and see if they tell us anything. The daily chart of the Industrial Average right now is exceedingly bullish. The market has gained about 28% since the recent low set last June with only one brief 3% correction (in November). RSI suggests the Dow is oversold and the index is trading well above the trendline and the 50-day moving average. After blowing right past 12,000, who knows what's next, but beware the inevitable selloff.

Like the Industrial average, the Transportation average has broken to new highs, re-confirming an interim bull signal according to Dow Theory. The index is also trading above both moving averages and the 50-day is much higher than the 200-day average. All of this is bullish. The next resistance level come in around 5,500 with strong support around 5,000.

In the past two years, the yield on the 10-year treasury went from 2% to 4%, then almost back to 2% before rising to finish the year around 3.3%. The yield has now risen above 3.6% and seems poised again to test resistance at 4%. That means substantial potential losses for bond investors. Remember, bonds are not riskless, as some believe; they are just different than equities.

Last Month's Results

• According to the Department of Labor, the figure for seasonally-adjusted initial jobless claims for the week ended February 121 was 410,000, an increase of 25,000 from the prior week's revised figure. The four-week average was 417,750, near the lowest figure since August 2008. The numbers have been very choppy for the past few weeks, possibly thanks to the bad weather throughout much of the country.
• Non-farm payroll employment increased by a meager 36,000 in January, while another 40,000 were reported as added through upward revisions to November and December. The majority of the private sector jobs came in manufacturing, retail and durable goods. Construction and transportation lost the most jobs. Average hourly wages for blue collar workers were up to $19.34, and the average work week inched down to 33.4 hours.
• The total number of workers counted as unemployed fell by 600,000 to 13.9 million (as people simply gave up looking and partly due to a new statistical model). Therefore the unemployment rate dropped to 9.0% (which shows just how useless this number really is). The more comprehensive U-6 rate jumped from 16.6% to 18.0%, or double the "stated" unemployment rate!! 6.2 million people continued to be unemployed longer than 27 weeks. The seasonally adjusted number of people who could only find part-time work dropped to 8.4 million and the number of marginally attached workers ticked up to 2.6 million. The number of people holding multiple jobs fell to 6.6 million. Overall, the employment picture remains poor and somewhat stagnant.
• The Congressional Budget Office (CBO) estimated that on a net present value basis, the Treasury reported a federal budget deficit of $53 billion in January, leaving us with a deficit of $423 billion for the first four months of fiscal 2011, which is $7 billion less than the same period a year ago.
• The Census Bureau reported that the U.S. had a trade deficit in goods and services of $40.6 billion in December, up from $38.3 billion in November. Exports rose nicely, but imports rose faster. It is mildly worrisome that the trade gap appears to be growing slowly and steadily after the economic crisis has abated.
• The Census Bureau reported that privately owned housing starts were jumped 14.6% in January, after being flat in December, but remained down 2.6% from a year ago, to a seasonally adjusted annual rate of 596,000 units. The bad news is that all the growth was in multi-family units; single family homes were flat month over month. New building permits were down 10.4% from the prior month and 10.7% from last year. Housing remains very weak.
• The National Association of Homebuilders/Wells Fargo Confidence Index in February remained at 16 for the fourth consecutive month. At least it isn't going down.
• The Census Bureau reported that on a seasonally adjusted annualized basis, sales of new homes in December rose 17.5% from the prior month, but remained 7.6% lower than a year ago, to 329,000 units. The estimate of homes for sale was 190,000, which represents 6.9 months at the current rate of sales. The median sales price was a higher $241,500, which is well above the rising 12-month moving average price of $220,483. Let's see if this can be the start of some positive momentum.
• The National Association of Realtors reported that on a seasonally adjusted annualized basis, sales of existing homes rose 12.3% in December, but remained 2.9% lower than a year ago, to 5.28 million units. The estimate of homes for sale, at 3.56 million represents a declining 8.1 months of supply at the current rate of sales. The median sales price dipped slightly to $168,800, which is slightly lower than the 12-month average of $172,483. The housing market is unlikely to get appreciably better any time soon. This number does not jibe with the results from new home sales.
• The S&P/Case-Shiller Home Price Index (10-city index), which uses a three-month moving average to track the value of home prices across the US, fell again in November, and were weaker than a year ago, giving further evidence of the trend of falling home prices across the county. While this is a trailing indicator, it does paint a bleak picture.
• According to RealtyTrac, the number of foreclosures in January increased 1.4% from the prior month, after falling 1.8% in December. The good news is that foreclosures were down 17% from a year ago. The number of foreclosure filings is expected to increase in 2011 once some of the litigation for "robo-signings" and other clerical problems are addressed. This will continue to be a big problem.
• The Institute for Supply Management (ISM) index of manufacturing activity was 60.8 in January, up strongly from the prior month. This marked the eighteenth consecutive month of expansion in the manufacturing sector. The ISM index of non-manufacturing activity was 59.4, also up strongly from the prior month. This marked growth in the service sector for thirteenth consecutive month. The "business" part of the economy continues to grow, but people are still not getting hired in any meaningful way.
• The Federal Reserve reported that in January, capacity utilization in the industrial sector was 76.1%, which leaves it only 4.4% below the average level of the period from 1972 through 2008. Capacity utilization improved slowly but steadily over the course of last year and appears primed to improve again this year.
• The Conference Board reported that it's index of Leading Economic Indicators increased by only 0.1% in January, following increases of 0.8% in December and 1.1% in November. Says Ataman Ozyildirim, economist at The Conference Board: �With January�s slight increase, following two large gains, the U.S. LEI is still pointing to economic expansion in the coming months. Falling housing permits and weakening labor market indicators were barely offset by the continued positive contributions of the financial components. The LEI remains on a rising trend, with its growth rate picking up in recent months. However, current economic conditions, as measured by the coincident economic index, while improving slowly, remain weak.�
• According to the Bureau of Economic Analysis, the "advance" estimate of GDP growth in the fourth quarter was an improved 3.2%, which is higher than 2.6% rate of growth in Q3 and 1.7% in Q2. GDP growth in Q1 was an artificially inflated 3.7%. The slight increase this quarter was due in part to increased spending on personal consumption and exports.
• The Federal Reserve reported that in December the amount of outstanding consumer credit increased slightly from the prior month, to $2.41 trillion. If consumer credit were to begin to expand again after falling for much of the past four years, it would be a boon to the economy.
• According to the Census Bureau, retail trade and food service sales were 0.3% higher in January, and were 7.8% higher than a year ago. The January increase was certainly muted by the horrible weather. And while the past few months have shown some modest improvements in retail sales, I continue to believe that until the employment numbers show some sustained growth, retail sales will continue to lag.
• The Federal Reserve reported in that in January the supply of M-2 increased slightly from the prior month and was up 5.1% during the prior six months. The supply of M-1, on the other hand, rose a whopping 14.2% over the same six months. The appears to once again be "priming the pump" to get the economy moving again, but ultimately, we need to see if this money will circulate more quickly in order to stimulate business growth.
• The Conference Board Consumer Confidence Index jumped in December from 53.3 to 60.6, the highest level since May 2010. Imagine how confident people would be if they had jobs. The index is still well below a healthy reading. An overall reading above 90 indicates the economy is solid, and 100 or above indicates strong growth.
• According to the BEA, the personal savings rate in December dipped to 5.3% from 5.5% in November. I would expect the savings rate to continue to trend lower from a high of 6.2% last June, thanks to a rising stock market and historically low interest rates on savings.
• According to the FDIC, 16 banks have failed so far this year, through February 11. 160 banks failed in 2010, surpassing the prior record of 140 banks that were either closed or merged into healthier banks in 2009. By comparison, 26 failed in 2008 and only 3 failed in 2007.

Trends To Watch

Over the past two years, the dollar has plunged and soared twice. Right now, the dollar index is sitting in the middle of a new trading range forming in the lower half of the larger bands. A generally weaker dollar tends to be good for hard assets that price in dollars, and for the overall market. Unrest in the Middle East could temporarily bolster the dollar, but I believe our budget woes mean that the dollar is headed inevitably lower.

As an investor, I have been riding the golden bull market for eight years now. I have championed the long term benefits from owning gold in virtually every issue of this newsletter. And I see no reason to change my tune now. I've been writing (and tweeting) that gold (and silver) prices have simply taken a breather and corrected for a bit. Gold has traded between $1,300 - $1,400/oz for the past five months, and may remain there a while longer. But I'm confident that the price of gold will again move north of $1,400 before falling below $1,300. Twice in the past two years there was a period of six to seven months where the price traded in a narrow range before bursting higher. We're now five months into the latest consolidation. I hope none of you are short gold right now.

While gold continues to get most of the headlines, silver continues its somewhat stealth bull market. After consolidating around $18/oz for most of 2010, the price of silver exploded to a new high over $31/oz. The inevitable correction brought the price down to around $26 before quickly turning around and returning to $30. I was a bit early when I started taking a position in some silver mining stocks a few years ago. I started adding to those positions late in 2008 and others through all of last year. Those decisions now are bearing fruit. I'm looking for the price of silver to move higher this year.

The price of copper has soared about 70% since the beginning of June 2010 and now sits at its all time high price. Like all commodities, copper is benefiting from a generally weak dollar and strong international demand (read: China). Remember, Dr. Copper is often thought of as a proxy for economic growth. So this chart is telling us that the prospects for future growth look good. That being said, a pullback is inevitable, so don't be surprised.

After trading between $70 - $85 per barrel for more than a year, the price of West Texas Crude rose 39% over the past seven months and reached a new period high of $93 before backing off to its current level of about $85. Interestingly, the price of Brent Crude today (which covers Europe, Africa and the Middle East, and represents about 2/3 of the world supply), is over $103/barrel. This disconnect must close either by Brent falling or West Texas rising; I'm betting on the latter.

It does appear that the financial sector index has broken definitively above resistance, proving me wrong in the process, as I've been a doubter since before Lehman fell. I remain almost entirely uninvested in the financial sector (my only holding being JPM) as I think problems remain thanks to troubles in housing. But you can't ignore the trend, which is decidedly bullish, at least for now.

The breakout in housing is not as strong as with the financials, largely because the problems in housing remain severe as the foreclosure crisis is far from over. Therefore, I remain bearish. But again, technically, things look good.

Over the past two months, the European stock market rose above powerful resistance, and a classic "rising triangle" pattern, to move to the highest level since the Crash of '08. The market seems to have discounted all the debt problems among the members of the Euro Zone. The next resistance levels come in at around $62 and $67.

This month, for the first time, I'm going to show a chart of the emerging markets. Notwithstanding the slight drop recently, thanks in large part I'm sure to the unrest in the Middle East, this index is at it's highest level since before the Lehman failure, and about 40% higher than last summer's low. The emerging markets are where most of the GDP growth is in the world right now, so we're going to pay more attention this year.

The health of the Chinese economy, and by proxy, it's stock market, is very important to the world's economy as they buy much of the world's output of raw materials and produce most of the goods sold to the world. Given the robust results from the US and Europe, you might think the Shanghai Composite would also be hitting new highs, but that's clearly not the case. The index is now trading around the middle of the range, and between their narrowing 50- and 200-day moving averages. The good news is that the index has turned up and is now trading above both moving averages, which is bullish

Last month I told you that the following chart was the most frightening of the month. The NYSE Bullish Percent Index represents the percentage of stocks listed on the NYSE that signal a buy. Contrarians would argue that extreme levels of exuberance is a bearish indicator, and vice-versa. I was concerned because of the huge over-abundance of optimism in the market at the time, which suggested that a move to the downside was forthcoming. Well, the best possible thing happened. Rather than a big drop, we've simply had a slow drift up, allowing the RSI to fall below oversold levels. There is still excessive enthusiasm, and a period of consolidation would be welcome, but this chart doesn't look quite as scary as last month.

Finally we have the VIX, or the "Fear Index". As you can see, there is virtually no fear in the market right now. Like the Bullish index above, too little fear is a bad thing, which suggests sometime soon fear will return in the form of a stock market correction, which is overdue anyway. But who knows when that correction will come, for as John Maynard Keynes once wrote: "markets can remain irrational far longer than you or I can remain solvent." Should the Middle East devolve into violence, the VIX could jump higher in a hurry.

What I'm Thinking and Doing

Last month I talked about eliminating the "noise" from the market and simply looking at the big picture. Right now, for the most part, that picture looks pretty good for the stock market. We have an accommodative Federal Reserve, stellar corporate profits, low interest rates and a lot of cash sitting on the sidelines. The economy is clearly better than it was a year ago, even if the employment situation remains problematic. As I mentioned in my Fearless Forecasts last month, I'm cautiously bullish for 2011, even as I acknowledge the strong likelihood of one or two painful corrections sometime during the year.

At the end of 2010 I held about $1.6M in cash across all of my accounts. Today our cash position has dropped to just above $1.0M as I continue to put our money to work in this bull market. I added to our precious metal holdings during the recent correct and that investment has already generated solid returns. My other recent acquisition was in the Rare Earth sector, and that investment is up more than 10% already.

Going forward, I expect to continue to make timely purchases and fill in existing positions for all my clients.

Personal News and Notes

The timing to move into my home office couldn't have been better. I managed to survive all of the snow storms without a minute of missed work. The only real change has been my already very informal work attire has gotten even more casual. My website has been updated, my new business cards and stationary have been printed and all my mail has been forwarded. The transition has been completely seamless and everything has worked perfectly. The next step, which I hope will happen by the end of March, will be the delivery and set up of my new office furniture. Be it ever so humble, there's no place like home.

Sometime within the next few months I hope to formally launch WAM's fan page on Facebook. I will let all of you know as soon as it's up and running. I hope you will all join me on the page and contribute to the content. For later in the year, I'm planning a blog which will be integrated between my website and Facebook. I would also urge all Twitter users to follow me there as I tweet content daily about the economy and the stock market.

I'm making a commitment to getting out and about more in 2011. So I'll be attending more industry events, networking functions and meeting with other industry professionals in order to expand my ability to more effectively serve the growing needs of my clients. So if you are in the New York area, and would like to meet, drop me a line and let's get together. Or if you're aware of a great networking event, let me know and I'll join you.

Don't forget that you can friend me on Facebook, connect with me on LinkedIn, or follow me on Twitter. I  tweet the latest market and economic news every day. Following me is a very easy way for you to receive stock market updates in between my newsletters. I've been using these three sites because I'm actively seeking to make new business connections as well as maintain contact with friends old and new. So please look for me out in Cyberspace, and ask your colleagues, friends and family members to do the same.

As always, I thank you, my readers, and remind you that this newsletter is for you. I have been writing to you now for over seven years. I hope some of you have learned something about our economy and our stock market, and that you will continue to follow along with me into the future. If you have any thoughts or suggestions on how to make it better, please let me know. And if you'd like to speak with me about your investment needs, I'd be pleased to be of service. Simply give me a call or drop me an email.

Best regards,

Greg Werlinich
President

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